Debt and Taxes: What You Need to Know Before You File
Preparing taxes falls among the list of least favorite activities. The paperwork, owing the IRS, and stressing about a potential audit, make the experience in line with getting a root canal. If you are looking forward to a refund, you want it to be as high as possible. A complicated tax code can make this a stressful venture. Knowing what is and is not deductible will help maximize your return and minimize what you owe this tax season.
Tax Deductible Debt
Home Mortgage Interest Deduction. As long as you itemize deductions you are able take advantage of a tax break on both the interest paid on your home mortgage and property taxes paid for the tax year. Payments received by December 31st will be reported from the mortgage company. The only restriction on this deduction is for homes with primary balances over 1 million dollars. In this case only interest applying to balances below the one-million-dollar threshold will be deductible.
Second homes, such as a vacation home, second mortgages, and equity lines of credit also benefit from tax deductible interest. This further reduces the cost of home ownership and many home owners leave a mortgage in place to benefit from this interest deduction. The interest on home equity lines of credit up to $100,000 is tax deductible even if the balance is used for non-home purchases. For more details on this deduction visit the IRS website at https://www.irs.gov/publications/p936/ar02.html.
Student Loan interest in repayment can be deductible up to $2,500 per year. Loan payments are eligible for those with income lower than $80,000 for single filers or $160,000 for joint returns. Recent changes to the student loan deductions has enabled students to deduct interest even if the parents are paying for the loan. Essentially the IRS determined these payments constitute a gift to the student, and can therefore be deducted by the student. For full details on this deduction the IRS website has a section at https://www.irs.gov/publications/p970/ch04.html
The student loan interest deduction is different from the home mortgage interest in that it comes directly off income without requiring itemized deductions. This benefits young adults who do not have enough itemized deductions and use the standard deduction when filing taxes.
Business Credit Card Debt is the only credit card debt to receive a tax benefit. For freelancers, independent contractors, or those who complete enough side work to file as a business, you are able to deduct not only business expenses, but also interest that is charged on those expenses. This deduction requires you to track expenses and interest to viable business use to qualify.
Debt as Income
The other side of the deduction coin is forgiven debt that can be reported as income. These are typically found from home foreclosures when the bank sold the home for less than you owed or when credit card debt is settled for less than the full balance.
Home foreclosure is considered debt forgiveness when the bank takes a loss after the sale of the home, which can lead to a tax liability. For the last several years’ congress has extended a waiver enabling families to forgo the tax penalty under certain circumstances.
Debt settlement can also trigger a taxable event if the company chooses to issue a 1099-C and report it to the IRS. There are some exceptions that can create a waiver of tax liability which are discussed here: https://financesolutions.org/1099-c-settled-debt/.
Understanding what can be deducted from your taxes could reduce the tax burden or increase the refund you will receive.